Fed's Paulson says current policy appropriate, but 'healthy' to consider extended hold or hikes

By Howard Schneider

AMELIA ISLAND, Florida, May 19 (Reuters) - The current level of interest rates is appropriate for the moment, putting downward pressure on inflation at a time when price pressures remain elevated, Philadelphia Federal Reserve Bank President Anna Paulson said on Tuesday, but she added it was "healthy" that investors had begun considering scenarios where rates might need to rise.

"Monetary policy is mildly restrictive and that restrictiveness is helping to keep the effects of both tariffs and the price increases associated with the conflict in the Middle East in check. Taking these ... factors together, I believe the current stance of monetary policy is appropriate," Paulson said in remarks prepared for delivery to an Atlanta Fed conference.

But she said her views about the risks facing the U.S. right now were aligned with how markets have been moving lately, as they have built up bets that the Fed's next move would be a rate hike, not the rate cuts that were expected at the start of the year.

"The way the market has moved in reaction to economic news over the last few months largely aligns with my own thinking," Paulson said. "I want to be clear: I believe monetary policy is in a good place now ... However, I think it is healthy that market participants have taken on board scenarios where the funds rate remains unchanged for an extended period, as well as scenarios where further tightening becomes necessary."

Paulson played down potential risks that could cause a worse inflation problem, with longer-term inflation expectations still contained and growth running around estimates of potential.

The Fed is expected to hold its policy rate steady in the current 3.5% to 3.75% range at its upcoming June meeting, the first led by incoming Fed Chair Kevin Warsh, whose swearing-in is set for Friday.

(Reporting by Howard Schneider; Editing by Edmund Klamann)